What the Big Money Likes in Oil and Metals

01/28/2010 11:09 am EST

Focus: STOCKS

Peter Way

Founder and CIO, Peter Way Associates

Peter F. Way, editor of Block Traders’ Oil & Gold Monitor, says the big market makers he tracks have some favorites in oil and silver.

Hedgers in crude [oil] have specific contract exposures in world energy production and consumption to protect. Their motivations, while influenced by anticipations, are solidly rooted in known obligations.

Gold, on the other hand, is driven by fear and the potential for profit by preying on those fears. There is no good way to tell how far folks will go in an extreme emotional situation.

[So,] let’s [first] take a look at the more rational situation in energy.

Since markets bottomed out in March 2009, energy industry expectations for crude have been quite stable.

Recently, the futures settlement prices have worked their way up. As the midyear and second half of 2010 approach, speculator prospects of crude prices above $100 a barrel are being embraced. They are seriously rejected in energy industry circles, where major market transaction volumes typically occur.

But the continued contango (where futures prices are higher than spot prices—Editor) in settlement prices rising across future dates testifies to an inevitable upward trend as energy consumption exceeds technology’s progress in developing new sources. The ecological “green” movement adds to this cost trend, since alternatives to existing energy sources are usually more expensive than the dominant carbon-based ones. (Nuclear power may be an exception.)

At this point, investment opportunities are most likely in those exploration and development companies that have reserves and are acquirable by the major integrated companies. The recent move by Exxon Mobil (NYSE: XOM) to pick up XTO Energy (NYSE: XTO) is an obvious signal that further activity in that regard is under way.

While far from earlier heydays when dozens of these companies offered odds-weighted probable returns above our minimum hurdle rate, there now are at least a handful of such candidates.

The biggest odds-on reward is CNX Gas (NYSE: CXG), a subsidiary of Consol Energy (NYSE: CNX), a major coal producer. CXG’s gas is recovered from methane entrapped in Consol’s US coal seams.

In our reward: risk rankings, CXG rates as more attractive than 92% of over 2,000 other stocks. (It closed above $28 Wednesday—Editor.)

[Meanwhile,] past excursions in gold prices have a sudden, violent, and unpredictable history. In hindsight, when the right guesses get made, the sagacity of the winners is unquestioned. But those living through the experience may pay a high anxiety price that is rarely discussed.

Still, our whole investment approach is built around understanding what active participants in investment markets expect to happen to future prices.

Those conjectures may be subject to sudden revision, so the risk content is substantial. But here goes. By far, the biggest payoff in prospect at present is in Ultra Silver ProShares (NYSEArca: AGQ), an ETF priced by two times the change in US dollar fixings in silver at the London Metal Exchange. Currently expected prices offer an attractive reward.

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